2. Statement of Cash Flows
• helps address questions such as:
How much cash is generated from or used in
operations?
What expenditures are made with cash from
operations?
How are dividends paid when confronting an
operating loss?
What is the source of cash for debt payments?
How is the increase in investments financed?
What is the source of cash for new plant assets?
Why is cash lower when income increased?
What is the use of cash received from new
financing?
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3. Internal Uses of CFS
Along side with cash budget CFS is used:
To assess liquidity
Determine if short-term financing is necessary
To determine dividend policy
Decide to distribute; or increase or decrease
To evaluate the investment and financing decisions
4. Preparing a Statement of Cash Flows
Prepared by
• calculating changes in all of the balance sheet
accounts, including cash
• listing the changes in all of the accounts except
cash as inflows or outflows
• categorizing the flows by operating, financing, or
investing activities
The inflows less the outflows balance to and
explain the change in cash.
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5. Four Parts of a Statement of Cash Flows
4-5
Cash
Operating activities
Investing activities
Financing activities
6. 4-6
Four Parts of a Statement of Cash Flows
Cash
• Cash and highly liquid short-term marketable
securities
• Also called cash equivalents
• If a company separates marketable securities into
two accounts (cash and cash equivalents and short-
term investments), the short-term investments are
classified as investing activities.
7. Classification of Cash Flows
Operations -- cash flows related to selling goods and
services; that is, the principle business of the firm.
Investing -- cash flows related to the acquisition or sale of
noncurrent assets.
Financing -- long term and short term cash flows related
to liabilities and owners’ equity; dividends are a
financing cash outflow.
8. Cash flow from operating activities
Examples (IAS No.7):
cash received from customers through sale of
goods or services performed;
cash received from non-operating activities such
as dividends from investments, interest revenue,
commissions, and fees;
cash payments to suppliers or employees;
cash payments for taxes and other expenses;
In effect, the income statement is changed from
accrual basis to cash basis
9. Investing Activities
Examples of investing activities include:
cash payments to acquire property, plant, and equipment
(PPE), other tangible or intangible assets, and other long-term
assets; and sale of such assets
loans extended to other companies; and collection of such
loans;
10. Financing Activities
Examples of financing activities are :
cash received from issuing share capital;
cash proceeds from issuing bonds, loans, notes,
mortgages and other short or long-term borrowings;
cash repayment of loans and other borrowings; and
cash payments to shareholders as dividends.
11. Format of the Cash Flow Statement
Name of the Company
Cash Flow Statement
For the period …
Cash from operating activities A
Cash from investing activities B
Cash from financing activities C
Net Change in Cash D = (A+B+C) increase or (decrease)
+ Beginning Cash balance CB, from the beginning balance sheet
Ending Cash balance =CB + D should equal to ending cash
balance in the ending balance sheet
Non-cash Investing and Financing Activities
12. Determination of Cash Flows From
Operating Activities
Direct Method
Income Statement items are converted to cash flows
individually
Indirect Method
Net income or loss is adjusted for accruals such as
accounts receivable and payable, and for non-cash
expenses such as depreciation
reconciliation of the accrual based and cash based
accounting
13. Comparison of Methods
Direct method of presentation calculates cash flow from
operations by subtracting cash disbursements to supplies,
employees, and others from cash receipts from customers.
The indirect method calculates cash flow from operations by
adjusting net income for non-cash revenues and expenses.
Most firms present their cash flows using the indirect method.
Only operating activities section is different between the
methods, investing and financing sections are the same.
14. How to prepare cash flow statement
Firms could prepare their own cash flow statement
directly from the cash account.
however, we need two consecutive balance sheets
and the income statement that covers the period
between the two balance sheets
15. Algebraic Formulation*
Assets = Liabilities + Shareholders’ Equity
or A = L + SHE
Assets are either cash (C) or not (Non-Cash)
Thus reorganizing
C + Non Cash Assets (NCA) = L + SE
C + NCA = L + SE
Where means the change in the balance of the item
from the previous period.
Solving for change in cash:
C = L + SE - NCA
Based on Stickney and Weil, 10th ed. Financial Accounting Slides http://www.swlearning.com/accounting/stickney/tenth_edition/stickney.html
16. Algebraic Formulation (Cont.)
C = L + SE - NCA
The change in cash, C, is the increase or decrease
in the cash account.
This amount must equal changes in liabilities plus
changes in shareholders’ equity minus changes in
assets other than cash.
Thus, we can identify the causes in the change in the
cash account by studying the changes in non-cash
accounts.
17. Indirect Method – cash flow from operations
Increase in non-cash
assets shows that cash
was spent,
so cash outflow.
Decrease in non-cash
assets shows that
they provided cash
so cash inflow.
Increase in liabilities
cash savings;
increase in SHE cash
received;
so cash inflow
Decrease in liabilities
or SHE shows
cash paid;
so cash outflow
Assets
Liabilities
and
Shareholders’
equity
INCREASE DECREASE
Adjusting Net Income of the period (accrual) to cash basis income
18. Indirect Method- operating activities-
Adjustments to net income
Net income
+ noncash expenses: depreciation, amortization,
uncollectible account expense,etc
+ loss on sale of asset
+ increases in current liabilities
+ decreases in current assets
- gain on sale of asset
- decrease in current liabilities
- increase in current assets
= Cashflow from operating activities
19. Noncash Expenses
Noncash expenses, such as depreciation expense,
are added back – because they were deducted to
measure net income but did not require any cash
payment in the current period
They are not truly sources of cash, even though
they are associated with cash inflows but reversal
of an accrued expense
20. Portakal Company
Prepare Cash Flow Statement
Accounts with Debit Balances 2008 2007
increase
(decrease)
Cash 37.500 39.250 (1.750)
Notes Receivable (from loans to other companies) 69.000 50.000 19.000
Accounts Receivable 53.700 39.900 13.800
Merchandise Inventory 158.000 120.000 38.000
Prepaid Operating Expenses 2.100 1.800 300
Interest Receivable 1.400 600 800
Land 110.000 65.000 45.000
Property,Plant and Equipment-PPE-net 377.000 380.000 (3.000)
808.700 696.550 112.150
Accounts with Credit Balances
Accounts Payable 45.000 38.000 7.000
Accrued Wages Payable 3.000 2.400 600
Income Taxes Payable 6.000 4.500 1.500
Unearned Revenues 2.500 1.250 1.250
Bank Notes Payable - long term 215.000 200.000 15.000
Common Stock; TL 15 par value 405.000 375.000 30.000
Additional Paid in Capital 70.000 50.000 20.000
Retained Earnings 62.200 25.400 36.800
808.700 696.550 112.150
21. Portakal Company 0
Income Statement 2008
Sales Revenue 750.000
Cost of Goods Sold (375.000)
Depreciation Expense (43.000)
Salary and Wages Expense (125.000)
Administrative Expenses (80.000)
Loss on Sale of Equipment (4.000)
Other Operating Expenses (5.000)
Interest Revenue 4.000
Interest Expense (20.000)
Income Tax Expense (28.000)
Net Income 74.000
The company paid TL 50.000 of Bank Notes and borrowed new bank loan.
The company declared and paid cash dividends.
The company issued common stock during the year .
The company sold equipment with a cost of TL 12000 and accumulated depreciation of TL
6000 for TL 2000 receving a note in return to be collected in 2009.
The company purchased equipment for TL 46.000; paid TL 44.000 in 2008 and gave a
note for Jan. 2009.
22. Portakal Company 2008
Cash Flow Statement
Cashflow from Operating Activities
Net Income 74000
Add back noncash:
Depreciation Expense 43.000
Loss on Sale of Equipment 4.000
121.000
23. adjustments that increase cash:
increase in Acct.Payable 7.000
Increase in Acc.Wages Payable 600
increase in Income Taxes payable 1.500
increase in unearned revenued 1.250
10.350
adjustments that decrease cash:
increase in Accts Rec. (13.800)
increase in Merch. Inv. (38.000)
Increase in Prepaid Expense (300)
increase in interest recev. (800)
(52.900)
Cashflow from operations 78.450
24. Cashflow from investing
Sale of PPE (note will be received in 2009)
Purchase of PPE (44.000)
Loans extended( to other companies) (19.000)
Purchase of land (45.000)
Cashflow from investing (108.000)
Cashflow from financing
Bank Notes Payable - long term 65.000
Common Stock; TL 15 par value 30.000
Additional Paid in Capital 20.000
Payment of Bank loan (50.000)
Payment of Dividends (37.200)
Cashflow from financing 27.800
Net Change in Cash (1.750)
25. Effects of a Sale of
a Long-Term Assets on Cash Flows
A few transactions complicate the derivation of a cash
flow statement from a comparative balance sheet, for
example, the sale of a long-term (or fixed) asset.
Recall the journal entry for the sale of an asset:
Cash nnnn
Accumulated Depreciation nnnn
Asset nnnn
Gain (or loss) on sale nnnn
26. Sale of an Asset
Each of the four parts of the above journal entry require
an adjustment in the cash flow statement.
The first line, cash, adds a line to the investing section.
The second line, a debit to accumulated depreciation,
increases the depreciation expense above the change
in the change in the accumulated depreciation account.
The third line, a credit to the asset, increases the
amount of cash invested in long-lived assets above the
change in the fixed asset accounts.
The fourth line, a gain or loss, is reversed out in the
operating sections since this is not a cash flow.
27. Steps to prepare CFS – indirect CFO
(1)Start with Net Income
(2)Adjust Net Income for non-cash expenses and gains
(3)Recognize cash inflows (outflows) from changes in current
assets and liabilities
(4)Sum to yield net cash flows from operations
(5)Changes in long-term assets yield net cash flows from
investing activities
(6)Changes in long-term liabilities and equity accounts yield net
cash flows from financing activities
(7)Sum cash flows from operations, investing, and financing
activities to yield net change in cash
(8)Add net change in cash to the beginning cash balance to yield
ending cash
28. Comparison of Cash Flow to Net Income
Net income is an accrual based concept and purports to
show the long-term.
Cash flows purport to show the short term.
Consider the outlook for both short-term and long-term and
consider that each is either good or poor.
A strong growing firm would show both good long-term and
good short-term outlooks.
A failing firm would show both poor long-term and poor
short term outlooks.
What about a firm with good cash flows (short-term) but
poor net income (long-term)?
What about a firm with poor cash flows (short-term) but
good net income (long-term)?
29. Analysis Implications of Cash Flows
• Some limitations of the current reporting of cash flow:
– Practice does not require separate disclosure of cash flows
pertaining to either extraordinary items or discontinued
operations.
– Interest and dividends received and interest paid are classified
as operating cash flows.
– Income taxes are classified as operating cash flows.
– Removal of pretax (rather than after-tax) gains or losses on
sale of plant or investments from operating activities distorts
our analysis of both operating and investing activities.
Limitations in Cash Flow Reporting
32. Analysis of Cash Flows
• In evaluating sources and uses of cash, the analyst
should focus on questions like:
Are asset replacements financed from internal or external
funds?
What are the financing sources of expansion and business
acquisitions?
Is the company dependent on external financing?
What are the company’s investing demands and opportunities?
What are the requirements and types of financing?
Are managerial policies (such as dividends) highly sensitive to
cash flows?
33. Analysis of Cash Flows
• Inferences from analysis of cash flows include:
– Where management committed its resources
– Where it reduced investments
– Where additional cash was derived from
– Where claims against the company were reduced
– Disposition of earnings and the investment of discretionary
cash flows
– The size, composition, pattern, and stability of operating cash
flows
Inferences from Analysis of Cash Flows
34. Analysis of Cash Flows
• Net income plus depreciation and amortization
– EBITDA (earnings before interest, taxes,
depreciation, and amortization)
Alternative Cash Flow Measures
35. Analysis of Cash Flows
• The using up of long-term depreciable assets is a real expense
that must not be ignored.
• The add-back of depreciation expense does not generate cash. It
merely zeros out the noncash expense from net income as
discussed above. Cash is provided by operating and financing
activities, not by depreciation.
• Net income plus depreciation ignores changes in working capital
accounts that comprise the remainder of net cash flows from
operating activities. Yet changes in working capital accounts often
comprise a large portion of cash flows from operating activities.
Issues with EBITDA
36. Analysis of Cash Flows
• While both successful and unsuccessful companies can
experience problems with cash flows from operations, the
reasons are markedly different.
• We must interpret changes in operating working capital items
in light of economic circumstances.
• Inflationary conditions add to the
financial burdens of companies
and challenges for analysis.
Company and Economic Conditions
37. Analysis of Cash Flows
Free Cash Flow
Another definition that is widely used:
FCF = NOPAT - Change in NOA
(net operating profits after tax (NOPAT) less the
increase in net operating assets (NOA))
38. Analysis of Cash Flows
Growth and financial flexibility depend on adequate free cash flow.
Recognize that the amount of capital expenditures
needed to maintain productive capacity is generally
not disclosed—instead, most use total capital
expenditures, which is disclosed, but can include
outlays for expansion of productive capacity.
Free Cash Flow
Positive free cash flow reflects the amount available for business
activities after allowances for financing and investing requirements
to maintain productive capacity at current levels.
39. Analysis of Cash Flows
• The SCF is useful in identifying misleading or
erroneous operating results or expectations.
Cash Flow as Validators
SCF provides us with important clues on:
Feasibility of financing capital expenditures.
Cash sources in financing expansion.
Dependence on external financing.
Future dividend policies.
Ability in meeting debt service requirements.
Financial flexibility to unanticipated needs/opportunities.
Financial practices of management.
Quality of earnings.
40. Specialized Cash Flow Ratios
Cash Flow Adequacy Ratio – Measure of a company’s ability to
generate sufficient cash from operations to cover capital expenditures,
investments in inventories, and cash dividends:
Three-year sum of cash from operations
Three-year sum of expenditures, inventory additions, and cash dividends
Cash Reinvestment Ratio – Measure of the percentage of
investment in assets representing operating cash retained and reinvested
in the company for both replacing assets and growth in operations:
Operating cash flow – Dividends
Gross plant + Investment + Other assets + Working capital
